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Investors as Market Makers

Ryan Frederick | March 31st, 2021

Some startups can be bootstrapped to achieve a similar outcome as an investment-backed startup.

Some investment-backed startups can achieve a positive outcome like an acquisition without a marquee investor(s).

And then there are the startups that need an investor to be a market maker for them to be successful.

Clubhouse is a great example of a startup that has been funded by and propelled by an investor. Andreesen Horowitz has not only led the funding of Clubhouse but has actively promoted and engaged with the app. Andreesen Horowitz partners and team members have actively participated in and have helped to organize other high-profile people to use the app. Let's assume Andreesen Horowitz believes in the Clubhouse premise, team, and business. Andreesen Horowitz might have invested irrespective of their desire or need to get involved to help drive awareness and use. But it could also be the case that Andreesen Horowitz invested knowing it would have to help the company to drive awareness and use. In either case, he has helped the company to have almost unprecedented growth, even though the app is still only available to iPhone users. Andreesen Horowitz is a market maker for Clubhouse.

We will see more VCs, especially the well-known and networked ones, becoming not only investors but also market makers for their investments. Money alone is so 2019.

The key for a startup is knowing whether they need a VC as a market maker or whether the company can fulfill its potential by receiving capital from investors. A startup that needs a market maker in addition to capital should be focused on a very small group of VCs as there are only a handful that have market maker capability.

So how does a startup know if it should have a VC as a market maker? Here are some traits I've identified:

• Network effect dependency - If a startup is reliant on a lot of people using the product for the company's business model to make sense and for the product to be of value.

• Big names as draws - If there is an influencer effect and component to the product that makes other people aware and to want to engage.

• FOMO - Will people want to engage, even if they don't know what value they are going to get out of engaging, all because they don't want to miss out?

• VC value beyond the $ - If the VC can increase their reputation and swagger as a result of being a Market Maker for a successful startup and that startup mutually benefits from the clout of the VC.

If your startup doesn't have these qualities, then it probably doesn't need a VC as a market maker. But if it does, then having one who is, can make all the difference between fighting a long, arduous slog through mud and having a nice, paved path in front of you.

Will we see more investors acting as market makers for their investments? A little, but I don't think it will be widespread. Most investors don't have the ingredients and the cache to pull off being a market maker for the companies they've invested in. Some investors who aren't currently market makers for their portfolio companies will try to be, but unless they evolve and become intentional about it, it won't work. Being a market maker as an investor isn't about referring or introducing a startup to a prospective customer or two. It is about the broad capacity and capability to drive awareness and engagement for a company in the millions, not twos and threes.

There is also another type of VC market maker emerging that will probably continue to fly under the radar as compared to the Andreesen Horowitz type of market maker. One such firm is Heartland Ventures. Heartland's model of LP's also being customers of Heartland's investments is interesting. Heartland recruits LPs with the intention and expectation that the LPs can and will be customers of startups Heartland finds that can solve problems for its LPs. It is a win-win-win. Heartland gets LPs who are invested beyond the money. The LPs get access to new ways of solving problems in their existing business. Startups get access to investment capital and early customers.

Heartland's market maker model appears on the surface to be easier to pull off than the Andreesen Horowitz one, but that would be underestimating the time, energy, and work that goes into cultivating LP relationships that isn't just about the capital. Heartland's model is a two-sided market each with its own requirements and needs to be managed and considered. It isn't as easy as it would appear to be able to manage both relationships with LPs as customers and investors. Heartland also can't appear to be leaning toward one side or the other and risk being labeled as playing favorites. They have to consistently balance the needs of the LPs and the companies especially as the relationship between the two of them also becomes a customer one.

Most investors don't have the ability or desire to be a market maker for their portfolio companies. Investors can help with business development and go to market advice in some cases, but they aren't going to create the market for a company.

Startups can't rely on an investor being a market maker unless a startup and an investor have intentionally agreed that the investor will serve that role as part of investing. And even when the investor being a market maker is agreed upon, a startup needs to do its due diligence on whether the investor can actually serve as an effective market maker since there are very few that can.

This begs the question, why does an investor decide to be a market maker for a startup? If we take the case of Andreesen Horowitz and Clubhouse there appear to be a couple of driving factors that also carry over to other similar situations. First, Andreesen Horowitz clearly believes Clubhouse could be big from every perspective. There's still a lot to figure out around the business model, but Clubhouse is positioned and, on a trajectory, to have the potential to attract and engage with a lot of users that it will eventually try to monetize. Second, Andreesen Horowitz believes in the underlying premise of Clubhouse that social engagement will evolve toward audio as much if not more than text and pictures. Third, Andreesen Horowitz's partners and team members have been early users of other social platforms. This appears to be in part because they like the value received by engaging in the platforms and what it says about how communication and social connectivity is evolving, but also because their engagement drives awareness for themselves and the firm as a leader in advancing new social platforms and usage.

Andreesen Horowitz has always been active with its own marketing, media, and content. In fact, the case could be made that Andreesen Horowitz defined the modern venture capital firm game by being so visible and intentional about its own marketing and positioning.

An investor as a market maker is because the investor likes what the company is doing enough to put their name and energy actively and publicly behind it. It is a commitment by the investor that they can't undo. This is why most investors don't market make even if they could.

If a startup needs millions of users to make the value proposition or economics work, it could probably benefit from a market maker investor. Or, in like Heartland Venture's case, a startup can benefit from some high-value, early customers that it would otherwise take them years to get if they ever did.